Economic Principles

Assignment Two

Introduction to the market:

In this assignment, I would be using the aeronautical market of India, it’s the market which produces good and services related to any equipment used for air travel. The aeronautical market has only one company called HAL (Hindustan Aeronautics Limited) in India. HAL is a state-owned aeronautical and defence company headquartered in Bengaluru, India since 1 October 1964. It is managed under the Indian ministry of defence. HAL operations involve the design, fabrication and assembly of aircraft, jet engines, helicopters and their spare parts. Its products and services include agricultural aircraft, fighter aircraft, helicopters, engines, trainer aircraft, observation & reconnaissance aircraft, transport & passenger aircraft, utility aircraft, gliders and unmanned aerial vehicles.

Market Structure

It is a structure where the behaviour of the firm(s) is influenced by the market’s characteristics like its consumers, suppliers, price, and cost of inputs and set of goods. It is also influenced by its competition, economies of scale, and policies of the government and so on. This assignment covers how HAL behaves under a particularly suitable market structure. To understand HAL market structure knowing what is a monopoly is important. “A market structure in which there is only one seller of a good or service that does not have a close substitute.”(Hubbard et al, 2015)

Hindustan Aeronautics Limited is a monopoly structured firm working alone in the aeronautics and defence industry. There are no substitutes to HAL in India and this makes it the single seller of fighter jets, helicopters, jet engines and so on. As mentioned earlier HAL is owned by the government of India and has no competitors.

HAL can be described as a combination of different types of monopolies and these can be:

 Government-mandated monopoly: Due to security reasons of the defence system of India as well as the safety of the passenger's government prefers to have only one producer of aeronautic equipment. This helps the government to supervise the quality and prevents the use of cheap products.

 Natural Monopoly: As the production of jets, helicopters and engines require complex and updated technology from time to time it creates a huge cost for sustaining in the market. Thus when Mr Hirachand identified the need for an Indian aircraft system back in 1940, then all the potential suppliers came together to work for HAL instead of starting their firm because of the cost-technology barrier.

 Multiproduct monopoly: As HAL produces more than one type of product and even provides services like designing and so on, thus it can be said that it is a multiproduct monopoly.

HAL produces goods and services in a quantity that is enough to fulfil its market demand at a price lower than its potential competitors if they existed. As HAL has operated in the market for more than 50 years it has practice and efficiency with technology and operations better than any potential competitor planning to enter the market. Not to mention the government does not provide licenses for aircraft production to any other firm after HAL. Thus significant barriers to entering this market include government policies, licences, costs & availability of inputs, technology, economies of scale and strong competition.

HAL’s market power

A firm’s market power is determined by its price and its marginal costs. Like other monopolies, HAL is also a price maker and will always prefer to keep price above marginal costs. In a perfect or competitive market price equal marginal costs to earn zero economic profits. But a monopoly-like HAL earns a positive economic profit and thus have a higher degree of power in the market.

Price, cost and profits

Whatever amount HAL makes by selling its outputs (like aircraft) at a given price at a given time is known as its total revenue for that period. Whereas total costs incurred by HAL while producing those outputs is known as the total costs of that period. Profit for that period is the difference between total revenue and total costs.

A firm needs to produce a given output at a given price where Marginal revenue {“The additional revenue to a producer from producing one more unit of a good or service” (Hubbard et al, 2015)} is equal to Marginal cost {“The additional cost to a firm of producing one more unit of a good or service”(Hubbard et al, 2015)} to maximise profit.

As HAL has power over setting its outputs price it can be called the price maker of its market which is also an assumption of monopolies. Being a price maker if HAL increases the price then it may lose a few customers but not all. Therefore it has a downward sloping marginal revenue curve and a downward-sloping demand curve.

 In figure one, the price set by the HAL would be Pm, where MR=MC and quantity supplied at this price is Qm. (Red line-MC, Yellow line-ATC, Green line-Demand and Purple line- MR, in all figures) Note that as HAL is a price maker of its market thus it decides the marginal revenue curve of its market as well.

Figure One

 In figure two, we can see that as HAL will earn positive economic profits (green area) producing inefficient output, consumer surplus decreases and producer surplus increases, also there is deadweight loss (orange area) due to the maximisation of profits.

Figure Two

 In perfect competition, demand is equal to marginal revenue, so the efficient price and costs (where there is no deadweight loss) would be at point E (Demand=MC) price at the given point would be Peff and quantity supplied by HAL will increase to Qeff.

 However, producing on the efficient point is not the solution for HAL or any other monopoly as it leads to economic losses (as seen in figure three). If it is forced to produce on an efficient level then it may shut down its operations.

Figure Three

 In such a situation where there is a threat of exploiting consumers by charging a higher price or production is way below the efficient level, the government intervenes to apply a few rules on the price makers. In this case, HAL will be instructed by the government of India to produce at a regulated price.

Figure four

 In figure four, we can see that regulated price (Pac) is derived at the point where average total cost is equal to the demand of HAL products. At the regulated price, HAL can break even on the investment by producing quantity Qr. Also, we can see that deadweight loss even though present has reduced to a smaller chunk.(Blue area)

The above-given diagrams justify why the government of India intervenes in the price setting of HAL products. It prevents an irrational increase in price by HAL and also ensures more efficiency in production.

HAL in the long run & Economies of Scale

Another reason for the difficulty in entering the aeronautic market is that HAL incurs decreased costs with an increase in inputs which is very difficult to achieve for a newcomer. Costs are too high for the new entrant to afford and make profit. Also if for some reason the demand for the HAL products falls then the firm would most likely shut down as the costs will increase enough to cause economic losses to the monopoly. This is the reason why government like to control the entry of new firms in a monopolist market as it may threaten the shutdown of the whole market if the consumers divide between the firms. Thus it is difficult for the size of the aeronautic market to change in India as economies of scale is in favour of only HAL.

HAL enjoys the same amount of profits and economies of scale in the long run as in the short run, unlike the competitive market. This is because HAL is not challenged in the long run from new firms for its profit which is the case for a competitive market.

Economies of scale enable HAL to benefit from lower long-run average costs. HAL operates on decreasing cost industry. Being a natural monopoly as HAL produces an additional aircraft the cost of producing that aircraft is lower than the first aircraft produced. In the graph above we can see that monopolies like HAL operate on the minimum efficient scale because of small or no competition and large production by just one firm. Thus size of the market operating on a minimum efficient scale is very small, ideally a monopoly like HAL.

“A decreasing cost industry exhibits economies of scale, where the technology is such that the scale of operation matters, so that the long-run average cost of production is lower for a large firm than for a small one. Economies of scale can combine with the size of the market to limit competition.” (courses.lumenlearning.com)

In conclusion Hindustan Aeronautic Limited functions as a monopoly with no competition, no substitute, economies of scale, inefficient level of production (deadweight loss) and decreasing cost industry. It makes positive economic profits and its market has barriers for entry for other competitors. It is a price maker but supervised by the government policies and enjoys licences benefits. Altogether HAL perfectly fits into the assumptions of a monopoly model.

References

 Hubbard, Garnett, Lewis & O'Brien, 2015, Essentials of economics, 3th edn, Pearson Australia Melbourne, Victoria, pp.212-232.

 Hindustan Aeronautics Limited, Hindustan Aeronautics Limited, HAL, viewed on 24 March 2021, https://hal-india.co.in/

 Courses lumen learning, How monopolies form.:barriers to entry, Courses.lumenlearning, viewed on 27 March 2021, https://courses.lumenlearning.com/wmopen-microeconomics/chapter/how-monopolies-form-barriers-to-entry/

 Wikipedia, Hindustan Aeronautics Limited, en.wikipedia.org, viewed on 27 March 2021, https://en.wikipedia.org/wiki/Hindustan_Aeronautics_Limited

Abbreviations

 MR-Marginal Revenue

 MC-Marginal Cost

 ATC-Average total cost

 HAL-Hindustan Aeronautic Limited